Guangdong leads China both in GDP growth and in NPL levels.

It's not the level of economic development that always determines a province's non-performing loan levels says a PBOC researcher. It can be something far more subtle - business ethics.

New research suggests that the non-performing loans which are dragging down China's banks are not distributed equally across the country or even that they are particularly high in the underdeveloped parts of the countries. Yi Gang, a researcher at the People's Bank of China, the country's central bank, says that regional attitudes to credit, closely linked to views on business ethics accounts for 70% of the explanation for bad loans, while ownership rights issues and management styles only explain 30% of existing NPLs.

As evidence he points out that Guangdong, the province with the highest provincial GDP in China and the highest growth rates also has NPL levels well above the national average and leads the country.

The areas of Zhejiang, Shanghai and southern Jiangsu are "normal" says Yi, in that economic growth rates are high, and NPLs are low, a function of vigorous firms and well-run banks. That tallies with their attraction to foreign investors, especially Europeans in Shanghai proper and hundreds and thousands of Taiwanese and tens of thousands of Japanese in the surrounding provinces, attracted by Huangpu River Delta's reputation as the most "orderly" market in China.

The three Northeastern provinces, Heilongjiang, Jilin and Liaoning predictably show the lowest rates of growth and the highest number of NPLs. That, says Yi, is due to their traditional role as a heavy-industry base under the direct control of the government - basically a relic of the centrally planned economy which has transformed these areas rich in natural resources into disaster zones. Still, the level of development of these provinces is around the mid point amongst China's 33 provinces, estimates Yi, but their level of NPLs is markedly higher. The interior provinces of Hebei, Henan, Hubei and Hunan are similar to the three Northeastern provinces, with high levels of NPLs due to decades of government intervention. The enormous undeveloped tracts of territory in the China's Far West show low growth rates and low NPLs.

Two factors contribute to NPLs in a province, continues Yi: the clarity of ownership rights and obligations within an enterprise and the role played by the local government.

In Zhejiang province, close to Shanghai, for example, none of the bank's branches operating there have high NPL ratios, be they branches of the state banks or of the smaller, shareholding banks such as Minsheng, which is private, and China Merchants Bank.

Yi attributes this low level of NPLs to the predominance of privately-held companies in the province. Their ownership rights and responsibilities are clear. They invest their own money, which tends to make them cautious. They also tend to be responsive to market forces and adapt to different situations in order to maintain their competitive advantage. And there is no involvement by the local government. Finally, private firms are determined not to lose their credit ratings by failing to repay money. Yi quotes one owner as saying: "If I fail to repay my loans, and lose my credit rating, that's the same as snatching the food from the mouth of my grandchild." Interestingly, Yi mentions that private managers are wary of resorting to the courts, as they feel the odds are stacked against them.

Yi concludes that a province's traditional and cultural attitude on the virtue of paying back credit is an important variable in estimating the ability of local firms to pay back debt. That attitude is often personified by the local government, which has an important role in signaling to bank's customers the degree of impunity they can expect if they welch on their debts.

Guangdong is clearly a dangerous place to do business in Yi's estimation, and he picks on Shantou City in Guangdong as an example of how business ethics (or a lack of them) can be a better predictor of the ability of a company to repay loans than its financial health. Shantou is famous in China as one of the cities from which a disproportionate number of overseas Chinese originate from. It's also been at the forefront of China's modernization.

In 1997 it was nominated amongst China's fifty most dynamic cities, and in 2001 it numbered 2500 foreign invested enterprises. But this promising city entered a crisis in 2001.

Such were the problems that companies from all over China had in getting their contracts respected by companies based in the city that 18 regions sent out a warning to all their companies not to do any business with companies based in Shantou.

The effect was electric. The city's laboriously built image came crashing down, and companies started almost overnight to move their headquarters out of the city. That year, the city's GDP saw its first ever year of negative growth, a 2% contraction for the year.

According to Yi, city officials have told him that they realize that allowing an unfettered free market is not enough - a government must ensure that it ensures a minimum level of fairness in transactions under its supervision.